At a Glance
Debt consolidation can be a helpful way to tackle debt. When used carefully, personal loans or balance transfer cards can even raise your credit score over the long run. If you miss payments or overspend, though, debt consolidation could hurt your score. Learn how to make smart decisions when you consolidate.
Things to consider:
What is Debt Consolidation?
When you consolidate debt, you take out a new loan to pay down high-interest debt. In doing so, you are rolling all your payments into one monthly bill, ideally with a fixed interest rate. There are several ways to consolidate. The most common methods are personal loans and balance transfer credit cards.
Should I Consolidate my Debt?
Depending on your financial situation and the approach you use, consolidating debt could save you money and help your credit score. Consolidation could also cost you in fees, interest, and more debt that hurts your score. Find out if debt consolidation is a good idea for you.
Find the Best Debt Consolidation Loan
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What debt do you want to consolidate?
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Others does not include mortgage
Debt Consolidation and Credit Scores
Proper management of consolidated debt can boost your credit score. It can improve your payment history, reduce what you owe, and more. If mishandled, consolidation could damage your score. Knowing what goes into your credit score makes this relationship easier to understand.
FICO weighs the following:
- Payment history (35%): Timeliness of payments, history of accounts in collection or bankruptcy
- Amount owed (30%): Your credit utilization rate (amount owed divided by credit limit); lower is better
- Age of credit (15%): How long accounts have been open; older is better
- Credit mix (10%): Account types; diversity is preferred
- New credit applications (10%): Hard credit inquiries, applications for multiple accounts in a short period; fewer is better
How Debt Consolidation Can Help my Credit Score
- Consistent payments: Repaying a loan or balance transfer card can boost your score. It builds your payment history and also shows lenders you’re dealing with your debt.
- Credit limit: Having a higher credit limit can lower your credit utilization ratio, improving your credit score.
How Debt Consolidation Can Hurt my Credit Score
- Hard inquiry: Applying for a loan or balance transfer card triggers a hard inquiry, which causes a slight dip in your score. The impact lasts only a few months.
- Canceling a card: Closing your old card will hurt your overall credit utilization. It also shortens your length of credit history.
- Reducing your credit mix: This is only one small factor in your score. You will be able to make up the loss in this area as you pay down your debt.
- Credit limit: If you transfer an amount near your new credit limit, you will hurt your score. Pay down debt as fast as possible to make this impact temporary.
Consolidate With a Balance Transfer Credit Card
Consolidating with a balance transfer credit card involves moving a high-interest balance to a new card with a lower rate. This method can improve your score over time, though it involves risks if mismanaged.
- A good or excellent credit score can land a lower interest rate plus 0% APR introductory period.
- Consistent payments can boost your credit score.
- Qualifying for a higher credit limit lowers your credit utilization ratio, improving your credit score.
- A hard inquiry will temporarily impact your score
- Not repaying before the intro period ends means higher interest rates and payments. This can lead to missed payments, affecting your score.
- May increase your credit utilization, hurting your score.
Consolidate With a Personal Loan
With this consolidation approach, you’re paying off your debts with a single personal loan. Again, if you pair debt consolidation with improved financial habits, your credit score will eventually rise. If you increase your debt–by, for example, refilling the credit cards you consolidated from–your score will fall.
- Qualify with a lower credit score than necessary for a balance transfer card.
- Consistent payments can boost your credit score.
- Can improve your credit mix and boost your credit score.
- May lower your credit utilization ratio, improving your credit score.
- May include a hard inquiry that will briefly lower your score.
- May lead to more debt if you use space on your old cards, raising your credit utilization ratio and lowering your credit score.
- Failure to make payments will harm your score.
Additional Ways to Consolidate
Other debt consolidation methods may also impact your credit score.
- Debt Management Plans (DMP):Working with a credit counselor or debt settlement company won’t affect your score unless you sign up for a DMP. A DMP involves negotiating for a lower repayment and stays on your credit report until completed.
- Home equity loan or HELOC: Either method will impact your score as they figure into your credit mix, amount owed, and payment history. Includes a credit check, which will temporarily lower your score.
- 401k loan: This type of loan is not included in your credit report and will not affect your credit score.